When in London next week I expect to hear a lot of discussion about the LME monthly versus the three-month contracts, its various participants arguing passionately as if the issue is about the very soul of the LME. What they don’t understand is that it is already too late, that in the battle for clients, the cannon roar is in a different country, some seven time zones away.
Our estimation at BANDS is that in total Chinese investors are now trading between 10-20 million lots of overseas futures contracts every month. The increase in volume has been recognised by the international exchanges.
The percentage of all contracts executed in Asian hours on the CME (8am until 8pm Shanghai) has risen from 19% in January to 26% in August 2016 and continues to climb. Whereas year-on-year the LME has seen a fall of 17% in executed contract volumes.
Attracted by deeper order books, tighter bid ask spreads and greater opportunity for cross border/cross market arbitrage, coupled with extensive face-to-face marketing throughout China, it can be argued the CME has now won the war for the hearts and minds and the trading volume of the Chinese high frequency or commodity day traders.
How can the LME fight back?
Therefore the question now is while offering the monthly prompts for those who want to use them, how does the LME win Chinese market share and anchor the international producer and consumer business that it still retains?
Based on the LME model, the HKEX is building a commodity trading platform to be launched in the free trade zone of Qianhai Shenzhen in 2017. As it is a physical spot market the HKEX sidesteps the regulatory requirements of the CSRC. The HKEX spot exchange plan appears to be supported by the PBOC and the State Council and Premier Li Keqiang recently made a visit to the exchange building.
Recently launched by the LME, LMEshield is a central electronic register for the secure creation and transfer of off-warrant warehouse receipts. Therefore the LME date system and the dynamic of the HKEX spot market based on LMEshield receipt transfers seem suited to each other, and drives to an area where the CME may not compete. It is not far-fetched to argue that the future of the LME relies on the senior management of the LME profitably combining the service offering of the LME and HKEX spot China market.
However, following my recent trips across China I feel that the relationship between the China’s base metals spot market and SHFE futures market is transparent, highly efficient and low cost. I recently toured an office building in Shanghai containing over 200 companies trading the premium between spot metals and the front month SHFE. Margins in this arena are already commercially thin, there is no appetite from those I met to pay the fees required for the new HKEX Exchange to operate. That said, the opportunity may exist as the yuan priced HKEX metals will be VAT free and warehoused in bonded locations.
Understandably the HKEX senior management want to retain the LME date structure so that the LME has a clearly defined separate contract identity to a standard futures exchange that dovetails into the HKEX platform, and satisfies the trade community. If the LME reforms too far, it fears the exchange will stray into CME territory, if it does not reform enough, it will become irrelevant to the largest growing customer base, the Chinese investor.
Rumours always flourish within the LME community, but some seem worrisome for LME strategy. CME warehouses in China, CME swap contracts, competitor spot platforms for HKEX of which there are 6 or 7. Within the gilded confines of the Grosvenor House ballroom the battle may seem far away. But in my opinion the metals community needs be told to march towards the sound of cannon fire and I can assure you that it is not in Finsbury Square, the real battle is for Shanghai.
Managing director, BANDS Financial Ltd